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Protecting the system

Monday's federal lawsuit filed against the debt rating agency Standard & Poor's comes as a surprise. The civil complaint alleges S&P fraudulently gave risky mortgage bonds solid ratings between 2004 and 2007 that helped fuel the financial industry meltdown and resulting recession.

Our surprise is not caused by the fact this is the first time the federal government has targeted a major rating agency, which it is. Nor by the fact it's a civil matter, as no criminal charges have been filed against any of the multitude of players contributing to the disaster. Nor that S&P was selected out of the three major agencies, as it was the one that downgraded U.S. long-term federal debt from AAA to AA+ a year-and-a-half ago.

What astounds us is that any charge was filed at all. The country, after all, is in its fourth year of recovery from the recession. While the middle and lower classes are yet to regain what they had prior to 2008, the wealthiest Americans already are surging forward.

And for the wealth inequality gap to continue widening, ratings agencies play a critical role. These companies are responsible for grading investments ranging from the mundane to the exotic. Without safe ratings on complex derivative products, for example, rich people can't place legal bets on whether poor people will be able to keep up on their house payments.

To threaten such a necessary piece of the financial services industry would appear to put at risk that portion of the GDP created out of thin air.

Not that S&P and perhaps others aren't deserving of a slap on the wrist. The charges allege S&P was well aware that home prices were dropping and many individuals were getting behind on their mortgages at the same time the company was giving safe ratings to instruments based on those factors. Bundles of mortgages and other debt needed high marks for banks and hedge funds to sell to investors such as pension funds and, as the suit points out, ratings companies are paid by those very banks.

This apparent conflict of interest has been around for awhile, with banks creating investments that require ratings -- and then shopping for the best rating. Agencies would, in turn, be paid large fees for the ratings.

"S&P's desire for increased revenue and market share ... led S&P to downplay and disregard the true extent of the credit risks," reads the government's lawsuit.

A spokesman for S&P said the suit was "meritless." The company did eventually downgrade the ratings on the most toxic bundles, some $2 trillion worth, which led the markets to panic.

A government official said S&P, if it loses, could be liable for at least $5 billion in civil penalties.

Our prediction would be a settlement under which S&P won't have to admit any wrongdoing but simply pay a fine, and the U.S. government makes grand pronouncements regarding insignificant changes in the way ratings agencies do business. That way, S&P, Moody's and Fitch all can consider such fines a cost of doing business and go back to rating financial instruments in a manner pleasing to those creating them.

Congress is loath to enact any real reform in the financial services sector. We don't see that mindset changing. Not when campaign coffers are filled by "persons" in the form of corporations, while real people -- the ones that bear the brunt of financial calamity in this nation -- are distracted by social issues.

Is this a great country or what?

Editorial by Patrick Lowry

plowry@dailynews.net